How Much Risk Can Your Portfolio Handle? It’s Likely More Than You Think

March 29, 2016

Logically, it would seem that a 40-year-old with more than two decades of income ahead of her before retirement would be open to taking more risks (with the potential for a greater reward) in her portfolio than a 60-year-old.

With retirement knocking at her door, a 60-year-old would seemingly be more fearful for her investments, since the time to recoup her losses through a steady paycheck is limited.

We’ve found this isn’t always the case, though, and people can be more or less able to handle risk at any age. Even at 60, it’s generally a good idea to be exposed to some level of risk, since you should be planning to live for at least another 25 years.

As financial advisors, we talk to our clients a lot about their risk tolerance: How comfortable are you when the economy is experiencing a downturn and all of the news seems to be negative? Among our clients, we see 10 to 20 percent who don’t really pay attention to the economic news of the day and another 10 percent who are the polar opposite, trying to analyze how every piece of information they hear will affect them personally. The vast majority of our clients live somewhere in the middle—they’re curious about market fluctuations and are thoughtful about how that might impact their portfolios.

History has shown us that a bad economy will always get better. And while we’ve always said this to our clients, it’s a concept that became a reality for the people nearing retirement age who rode through the most recent U.S. recession. We share their stories with young risk-averse clients today as an extreme real-world example.

One Example

As the economic situation worsened in the late 2000s, we had one high-net-worth client who had started contemplating retirement, and who was starting to worry. He wasn’t alone—we heard from almost all of our clients on a regular basis during this time period.

We walked him through a worst-case scenario and showed him what his portfolio would look like if he permanently lost 20 percent of his assets. With the balanced plan that we created with him, we showed that even in this highly unlikely scenario, he was going to be fine and would sustain his lifestyle throughout his retirement, even with only a few more working years ahead of him.

This client, and many others like him, learned that portfolios eventually turn around, even from the worst of times. While the market has experienced fluctuations since this era, we rarely hear from a majority of clients who survived the Great Recession. Their portfolios recovered from one of the worst economies our nation has ever experienced and they know that any minor jolt to the markets shouldn’t be cause for panic.

Risk and Youth

When we talk to our younger clients about risk tolerance, we try to teach them the lessons learned first-hand by the sturdy bunch of investors whose portfolios survived past economic crises. When you’re 30, the market very rarely impacts your long-term outlook. But even some people in the younger generation get concerned when they read negative economic headlines.

For this segment, we try to ease their concerns in two ways.

First, we guide them through all of the news that is out there and we direct them to the most important facts that relate to their specific situation. We help them put everything in perspective.

And then we take them back to the plan we created for them during better times. We remind them that we planned for downturns, and that they do not want to make major changes in a portfolio when there is volatility in the markets. In some cases, we may recommend to younger clients that it’s even a good time to jump into the market at a discount, even though they might have to hold their nose while doing so.

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